Debt Versus Equity Financing
May 14, 2012
Debt versus Equity Financing
Debt versus equity financing is a critical element in the process of managing a business and also the most challenging decision facing managers who require capital to fund their business operations (Schroeder, Clark, & Cathey, 2005). Debt and equity are the two main sources of capital available to businesses, and each offers both advantages and disadvantages.
This paper will compare and contrast lease versus purchase options, examine debt and equity financing, provide examples for each source of financing, and identify which alternative capital structure is more advantageous.
Lease vs. Purchase Options: Compare and Contrast
In business the decision to lease or purchase is a critical element of strategic management. Equally important is the way in which the asset will be used. Operating leases are most often used by organizations looking for fixed payments with no long-term risk, and a limited useful life of the asset. Capital leases are more aligned with the features of a conventional purchase. Purchasing often requires a higher monetary expenditure at the start, in addition to acquiring the financing to purchase through a lender. Leasing usually requires a lesser amount of cash down, and the monthly payments are often smaller. Additionally, leasing offers tax benefits because the full lease payment can be immediately deducted, whereas purchasing only allows the interest portion to be deducted. Debt Financing
Debt financing occurs when a business raises money for working capital or capital expenditures by borrowing money from individuals, banks, and financial institutions, and in return for lending the money, the individuals, banks, or financial institutions become creditors and receive a guarantee that the principal and interest on the debt will be repaid (Investopedia, 2010). Examples of debt financing include long-term debts, which usually pertain to...
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